The Bizarre Story Behind Today's Sudden Ruble Rally

On Thursday, the Russian ruble reversed its recent trend of breaking record lows against the dollar and the euro and came surging back.

Rumors quickly circulated about the cause of the unexpected rally.

Here's what we know so far:

After falling to yet another record low in early trading, the ruble suddenly began regaining lost ground from around 6 a.m. ET.

BloombergRuble vs the dollar.

The first thing to note here is that over the past week the volume of trading in ruble markets has fallen off sharply. As Reuters' Eric Burroughs (who provided the chart below) said on Twitter, this suggests that the ruble falls have been increasingly built on fragile foundations. It also indicates that today's rally could reflect low volume of trades rather than a genuine change in sentiment.

However, there are a few reasons to believe that the rally may ultimately have some legs.

Thomson Reuters Eikon/Eric BurroughsUSD/RUB trading volumes (DTCC reported)

The Russian central bank is due to meet tomorrow to decide on whether to move interest rates.

At the top of the list of concerns will be ruble movements, which have forced it to spend $15 billion of foreign exchange reserves buying up the currency in an attempt to limit the scale of its collapse. However, it will also be painfully aware that it has to deal with the competing problems of inflation at 8%, well above the central bank's 5% target, and an economy stuck in the doldrums due to international sanctions and weakening domestic demand.

Markets appear to be anticipating a modest move by the central bank to keep inflation in check and help slow capital outflows, with analysts in the latest Reuters poll predicting a 50 basis point rise. If currency traders believe higher rates might succeed where foreign exchange have failed in stemming the outflows, which have so far seen over $86 billion of capital flee the country in 2014, then the rally could well become more entrenched.

The risk, of course, is that a rate rise also chokes off what little growth the Russian economy is currently forecast to achieve this year sending the country into recession.

Another rumor swirling Thursday was that Bogdan Yaremenko, a Ukrainian diplomat, was briefing journalists that Russian President Vladimir Putin had struck a deal with his Ukrainian counterpart Petro Poroshenko over gas supplies to the country and the disputed territory of Crimea.

EU-brokered talks between the two sides appeared to have stalled earlier this week over Moscow's demand that Brussels and Kiev come up with a plan for Ukraine to pay off its gas debts before entering into negotiations. The talks were supposed to ease tensions ahead of elections planned this weekend by pro-Moscow rebels in the parts of eastern Ukraine under their control.

Signs of de-escalation in the conflict would be welcomed by markets, not only as it reduces the chances of further destabilization in the region but also because it could be used as a reason to soften or remove sanctions against Russia when they come up for review next year.

The European Union is scheduled to review its sanctions package in March. Extending the sanctions requires a unanimous vote by member states, an eventuality that would be much less likely if there was tangible evidence of tensions cooling. This would provide a big boost to Russia's economic outlook and help improve investor confidence in the country - likely leading to a strengthening ruble.

So is this what we're seeing in the ruble market? Perhaps. But unfortunately this latest rumor looks to have little to support it. Dmitry Peskov, Putin's spokesperson, has been quoted as saying, "I have no idea who Bogdan Yaremenko is, we have more than 3,000 such diplomats."

His comments were reaffirmed by Alexei Miller, chief executive of Russia's state-owned gas behemoth Gazprom, who said that if there was no agreement over debt repayment "naturally, there will be no meetings, no talks tomorrow and no documents will be signed."

What's underpinning the ruble rally may simply be a perception that the currency had become oversold in recent weeks but the situation remains precarious. Concerns now will be focused on Russia's corporate sector with Rosneft reporting that the ruble collapse effectively wiped out third quarter profits and prompted it to request a (likely unrealistic) 2 trillion ruble bailout from Russia's sovereign wealth fund.

Russian companies still have $140 billion in foreign debt repayments due by the end of 2015, and further ruble weakness could cause this problem to become a self-feeding cycle. If it does, the ruble flash rally may quickly be forgotten about.